General Electric Company (GE) — Q4 2017 Earnings Call Transcript

Good morning and welcome to today's webcast. I'm here with our Chairman and CEO John Flannery; CFO Jamie Miller; and GE Power CEO Russell Stokes. Before we start, I would like to remind you that the press release, presentation, and supplemental have been available since earlier today on our investor website at www.ge.com/investor. Please note, some of the statements we are making today are forward-looking and are based on our best view of the world and our businesses as we see them today. As described in our SEC filings and on our website, those elements can change as the world changes. And now, I’ll turn the call over to John.

Thanks, Matt. Before I start on the quarter, I'd like to take a moment to step back and review where we stand and the progress we've made in just a short time. You've heard a lot from us since I became CEO in August. I recognize that the news we've shared in that time, specifically around Power and Insurance, has been tough. We are moving very quickly to tackle these issues, and we are doing so in the context of running our businesses for the long term. Our responsibility is to reshape this company and ensure that GE matters as much in the next century as it has in the past one. And as I take stock today, I feel good about the progress we are making and especially good about the strength of our team. We have a long way to go, but the mission is clear, and we are moving forward together as one team with a single purpose. The backbone of our recovery is stronger execution. Back in November, we laid out a new vision for the future, the foundation of which was improved execution, an obsession with cash generation and capital allocation, a more focused digital and additive strategy, and a rapid reshaping of the portfolio to become a simpler, more nimble organization. Today, I'm proud to report that this organization is responding, and we are beginning to show progress against each of our key initiatives. The teams have stepped up and embraced the challenges. And in this quarter, we are beginning to see the signs of what they can accomplish when called upon to pursue common goals and drive improvement. We have a lot to work on, but we also have a lot to work with. The team and I are as convinced as ever that the strength of our core businesses remains intact. We have valuable franchises with leadership positions in key global markets. And we have a path ahead that will create the best outcomes for our customers, great opportunities for our team, and will create value for our shareholders through stronger execution and more disciplined operational performance. As I said, the results this quarter demonstrate some of the early progress we are seeing across our key initiatives. In Healthcare, we introduced 26 new products in 2017, and we're especially proud of the new Senographe Pristina mammography system. It’s the industry's first patient-assisted mammography device, and it's indicative of the kind of innovation and investments we are making to improve Healthcare and save lives. It has also resulted in significant market share gain and profit margin gain. In Aviation, I am excited by the progress we are making in Additive. In the quarter, we announced the world's largest laser powder additive manufacturing machine. It will print in a build envelope of one meter cubed, which is suitable for jet engine structural components. Our additive capabilities are truly game-changing, and we expect to increase the pace of additive utilization to drive higher margins and innovation across our businesses in 2018. We shipped 119 units in the quarter and 294 in the year, while our backlog in the fourth quarter was up 44% from last year. Additive is positioned to break even in 2018, and we believe there is tremendous potential here. While the Power market remains challenging, we have made progress in rightsizing the organization, taking out $800 million of costs and rationalizing our manufacturing footprint. We continue to see cost opportunities here and are laser-focused on achieving them in 2018. The team is up for the challenge and is focusing above all else on delivering for our customers. At Baker Hughes, the team is demonstrating disciplined execution in successfully capturing synergies through the integration. The business has a clear path for profit growth in 2018. I am also pleased with Digital's performance in the fourth quarter as we refocused our strategy on our core markets. Predix-powered orders were up 41%, and we did $1.4 billion for the year, up 150%. The team is driving customer outcomes with APM, OPM, and ServiceMax. We have only penetrated 8% of the installed base today, so there is a lot of opportunity here, and we are aggressively going after it. With respect to our key operating priorities, let's start with cash. Cash in the fourth quarter was significantly better than we planned, about $2.5 billion higher. About half of this was due to the timing of progress payments, and the other half was a result of better execution. As you recall from our discussion in November, cash has been our number one focus and also in the minds of our investors, given the weak performance we had through the first three quarters. The results this quarter reflect more discipline and execution. We are focused on improving our visibility, execution, and tenacity on cash. It's a similar story on costs. We came into the year with a structural cost-out target of $1 billion. We raised that in the third quarter to $1.5 billion, and we delivered a little higher than that, at $1.7 billion for the year. We have strong execution and discipline on costs. We are targeting an additional $2 billion out in 2018. In addition to that, we are particularly focused on product costs, attacking cost of quality, reducing manufacturing overhead, and accelerating the implementation of additive design and manufacturing. We are confident that we will deliver on that goal. The team is also highly active in working towards simplifying the portfolio. We currently have over 20 dispositions in active discussions, and you will begin to see tangible results in the coming quarters. We ended the year with $11 billion of GE Industrial cash. There is no change to the capital allocation plan previously communicated on November 13. We plan to increase our cash balance in 2018 and exit the year with over $15 billion of cash. We will make a voluntary $6 billion debt-funded contribution to our principal pension plan. And we will maintain a disciplined financial policy targeting 2.5 times net debt to EBITDA and A1/P1 short-term ratings. We are on track to shrink the Board from 18 to 12, including 3 new directors. We expect to be in a position to announce the new Board prior to the proxy statement. So at the overall company level, we are intensely focused on operational rigor, cash and capital allocation, and deep cost reduction. Our first priority is running the Company well. As I mentioned last week, at the same time, we are reviewing the best structure of the Company to maximize the long-term potential of our businesses and deliver the best value for our customers and employees. We have a team dedicated to considering all the details and looking at the options that will deliver the best value for our shareholders and the most attractive jobs for our employees. The truly enduring strength of GE lies in our people. There will be a GE in the future, but it will look different than it does today. We will update you when the team has made further progress. I am very pleased that we are beginning to show these tangible signs of progress, but I'm also cognizant this is only the beginning. 2018 is a critical year for us, and we intend to continue demonstrating in the coming quarters that our new approach is working and the organization is changing. With that, let me turn to the quarter. Clearly, 2017 was a challenging year for us, and the fourth quarter had a lot of moving pieces. We had significant charges in the quarter for insurance, tax reform, and planned portfolio moves. These charges totaled $1.49 of EPS. Excluding those charges, adjusted EPS was $1.05, at the low end of the EPS guide we gave you for the year. Issues in the quarter were mostly localized to Power. The power market continues to be challenging. Power earnings were down 88% in the quarter, driven by the market, certain execution misses, and other charges. This is an important franchise going through a difficult period. The team is working with amazing dedication and resilience, and they have the support of the entire GE Company behind them. I've asked Russell to give you an update on the quarter and take you through our action plan on the business in a few minutes.

Thank you, John. On November 13, I shared with you that we had a significant opportunity to improve the way we run the Power business. I spoke of fixing operating misses, the prioritization of cash performance, in line with a focus on income. I outlined our return to driving a more holistic services capture of dollars per installed base versus pursuing upgrades and productivity in our contractual portfolio. I am confident in what I said in November. And I will talk in more detail about what we are doing to move the business forward. But let me first walk you through the results for the fourth quarter and the impact on the total year. Starting with a view on orders, our orders in the quarter were down 25%. Equipment orders of $5.3 billion were down 24%, driven by GPS being down 63%, primarily on lower combined cycle turnkey scope. In the quarter, gas turbine orders were up 1 unit at 24 versus 23 units in the prior year, with the increase driven by nine H units versus eight in the prior year. Total-year gas turbine orders were 75 units, which is down 9 versus the prior year. Aero units were also lower, with 3 units ordered in the quarter versus 24 last year, with total-year units at 46, down 33 versus the prior year. In December, we noted that the market was softer than expected, with McCoy comments indicating that the industry could be heading for the lowest gigawatt year since 2002. We announced a 12,000-person reduction and a commitment to right-size our global manufacturing footprint. We believe that total gigawatts awarded will be even softer than we thought in December, coming in below 35 gigawatts in 2017. We still anticipate, though, roughly a 50% share of the market in 2017. We are working to accelerate additional restructuring efforts in 2018 to support a market that could be as low as 30 gigawatts. Service orders were $4.9 billion, down 26% on lower AGP orders, which were down 59% at 24 units versus 58. This was partially offset by higher grid solution services, which were up 54%. In the quarter, Power revenues were down 15%. Equipment revenues of $4.5 billion were down 15% on lower aero units. Aero unit shipments were at 3 versus 31 last year, accounting for all of the decline. Total-year aero shipments were 40 versus 95 last year. Aero units, particularly our fast-power TM units, are typically convertible within the quarter. These units serve customers in difficult geographies and usually require some form of financing arrangements. We have transactions in the pipeline we expect to close in the first half of the year, but we believe that the 2018 aero shipments will be in the 30 to 40-unit range. We shipped 39 gas turbines in the quarter, 4 more than the prior year, including eight H shipments versus nine last year. This would put total-year gas turbine shipments at 102, in line with our estimate of 100 to 105 unit range. In 2018, we expect shipments to be 60 to 70 units, with 15 H units in that count. Services revenues were $4.9 billion, down 16% on lower CSAs and upgrades down 17%, and outages down 10%. AGPs in the quarter totaled 25 versus 62 last year. This puts our AGP shipments at 80 versus total year, at the lower end of the 80 to 85 range we provided in November. For 2018, we expect about 40 AGPs. Operating profit of $260 million was down 88% or $1.9 billion and significantly below our expectations.

Thanks, John. Before I start with consolidated results, I want to remind you of some of the changes to our reporting metrics in 2018 that we discussed in November. First, on EPS, this is the last quarter that we report Industrial plus Verticals EPS. In addition to GAAP earnings, we will report an adjusted EPS number, which is total continuing operations excluding Industrial gains, restructuring, and non-operating pension expense. On cash, we will move to reporting free cash flow as opposed to CFOA. And lastly, two changes related to the adoption of the new revenue recognition accounting standard. As of January 1, 2018, our contract asset balances will be adjusted to reflect the new standard, resulting in a lower asset balance and lower earnings going forward. This doesn't change anything related to our cash balances or cash flows. We will provide restated 2016 and 2017 quarterly information on a basis consistent with the new accounting. We are still in the process of finalizing the newly restated financials, and we will provide them to you shortly after we file the 10-K. Related to the accounting standard change is also a move to reporting remaining performance obligations, or RPO. RPO is a new GAAP measure, and we will report RPO in the first quarter once it is implemented. Additionally, you may have noticed that our earnings press release has a new format. We believe it's more substantive and more easily digestible. We will continue to re-look at all of our communications formats and data that we provide to investors with the goal to continue to increase standardization and transparency. So you will likely see more changes as we move through 2018. Next, on consolidated results, fourth-quarter revenues were $31.4 billion, down 5%. For the quarter, Industrial plus Verticals EPS was negative $1.23, down from $0.46 in the fourth quarter of 2016. Included in the negative $1.23 was $1.49 of charges driven by the Insurance-related adjustments we discussed last week, the impacts of tax reform, and portfolio-related actions we are taking in Industrial. Excluding these items, Industrial plus Vertical EPS was $0.27 in the quarter, still down significantly year over year, driven principally by the Power segment. Operating EPS was negative $1.11. This incorporates other continuing GE Capital activity, which I will cover more on the GE Capital page. Continuing EPS of negative $1.15 includes the impact of non-operating pension, and net EPS of negative $1.13 includes the results of discontinued operations. Next on taxes, the GE Industrial tax rate was negative 576% in the quarter, reflecting a tax charge on a pre-tax loss. This includes charges in the quarter related to US tax reform. And excluding tax reform and Industrial gains, restructuring, and fourth-quarter other charges, our tax rate was negative 7% for the quarter and positive 15% for the year. On the right side are the segment results. Industrial op profit was down 33%. The decline year over year was driven principally by Power and Oil & Gas and partially offset by Aviation, Healthcare, and Corporate, better year over year. As John mentioned, we took another $500 million of structural cost-out in the quarter, and I will cover the individual segment dynamics separately. On the next page, our reported cash from operating activities was $7 billion in the quarter. That represents GE cash flow, including 100% of Baker Hughes CFOA. We did not receive a dividend from GE Capital in the quarter, and this is in line with our prior communications. We don't expect to receive a dividend from GE Capital for the foreseeable future. Our Industrial CFOA was $7.4 billion in the quarter, adjusted for $400 million of US principal pension plan funding and deal taxes. And this is down $800 million from the prior year. With Baker Hughes GE on a dividend basis, and excluding Baker Hughes GE CFOA, our Industrial CFOA was $7.8 billion. For the year, our total Industrial CFOA, adjusted for Baker Hughes GE, was $9.7 billion. This came in above our full-year guidance of $7 billion, driven primarily by better-than-expected progress collections and contract asset performance. The Aviation and Healthcare businesses turned in strong performances, and the cash performance of Power was in line with expectations. On the right-hand side, I have some color on the components of cash activity in the fourth quarter. First, working capital generated a total positive flow of $3.9 billion, principally driven by better inventory flows from higher shipments and higher-than-expected progress flows of about $700 million. This was partially offset by an increase in receivables, consistent with our sequentially higher sales in the fourth quarter. Contract assets were flat during the quarter on favorable cash inflows from lower CSA contract asset growth, offset by cash usage from growth in deferred inventory in Power and Renewables. All other operating cash flow, including deferred taxes, was a $6 billion inflow, driven primarily by non-cash expenses such as held-for-sale charges, the impact of tax reform, and amortization of intangible assets. For the year, we generated $5.6 billion of free cash flow with an 81% conversion rate. There is no change to our 2018 guidance of $6 billion to $7 billion of free cash flow. However, in 2018, we expect the challenging power markets to continue and potentially be worse than we expected. Additionally, the accelerated progress collections in the fourth quarter will present some headwinds to our free cash flow, particularly in the first quarter, which is always our lowest cash quarter. We are planning for a negative free cash flow quarter in the first quarter. We remain focused on our operating rigor and execution on cash, with compensation heavily tied to cash performance. We are evaluating incremental restructuring at Power. We will update you on this as decisions are made.

Thank you, John. Before we wrap up, I would just like to thank everyone for joining today. Reminding you that a replay of today's call will be available this afternoon on our investor website.

Great, Matt. I want to conclude by sharing three key thoughts as I reflect on the quarter and look ahead to 2018. First, we are committed to optimizing the operation of every asset we own, focusing on fundamental aspects such as costs, cash, capital allocation, workforce, and project execution. We saw signs of progress in Q4, which I view as encouraging and indicative of our core priorities for the business moving into 2018. In November, we discussed our attention on Power, Aviation, and Healthcare, and we are very optimistic about our positions in these areas. I am determined to ensure these businesses are equipped to prosper in the future, with adequate resources and investment flexibility. We are considering every option available to ensure their success not only in 2018 but also for the next five, ten, and twenty years. Our aim is to establish the best prospects possible for these businesses, benefiting our customers and our teams. Getting this right will ultimately benefit our shareholders as well. Lastly, I want to highlight that after nearly six months as CEO, the most rewarding part has been observing our GE team closely. They are incredibly passionate about our businesses, dedicated to our customers, and supportive of one another. Importantly, as we transition from 2017 to 2018, this is a highly competitive team with a strong desire to succeed. When I consider the overall landscape for GE, I consistently return to the strength of our 300,000 employees. As we head into 2018 together, I am confident that our team and the strength of our businesses will enable us to achieve our goals.